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Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2023

ASC Topic 820, Fair Value Measurement, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 also specifies a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1 Quoted prices in active markets for identical assets or liabilities

Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying condensed consolidated balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.

Available-for-Sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid mutual funds. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows.

Level 2 securities include U.S. Government-sponsored agencies, municipal securities, mortgage and asset-backed securities and corporate securities. Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities.

In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. Fair values are calculated using discounted cash flows. Discounted cash flows are calculated based off of the anticipated future cash flows updated to incorporate loss severities. Rating agency and industry research reports as well as default and deferral activity are reviewed and incorporated into the calculation. The Company did not own any securities classified within Level 3 of the hierarchy as of September 30, 2023 or December 31, 2022.

Loans Held-for-Sale (mandatory pricing agreements)

The fair value of loans held-for-sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan (Level 2).

Servicing Asset

Fair value is based on a loan-by-loan basis taking into consideration the origination to maturity dates of the loans, the current age of the loans and the remaining term to maturity. The valuation methodology utilized for the servicing asset begins with generating estimated future cash flows for each servicing asset based on their unique characteristics and market-based assumptions for prepayment speeds and costs to service. The present value of the future cash flows is then calculated utilizing market-based discount rate assumptions (Level 3).

Interest Rate Swap Agreements

The fair values of interest rate swap agreements are estimated using current market interest rates as of the balance sheet date and calculated using discounted cash flows that are observable or that can be corroborated by observable market data (Level 2).

Back-to-Back Swap Agreements

The Company offers interest rate swaps to certain loan customers to allow them to hedge the risk of rising interest rates on their variable rate loans. The Company originates a variable rate loan and enters into a variable-to-fixed interest rate contract with the customer. The Company also enters into an offsetting interest rate swap with a correspondent bank. These back-to-back swap agreements are intended to offset each other and allow the Company to originate a variable rate loan, while providing a contract for fixed interest payments for the customer. The net cash flow for the Company is equal to the interest income received from a variable rate loan originated with the customer. The fair value of these derivatives is based on a discounted cash flow approach. The fair value assets and liabilities of centrally cleared interest rate swaps are net of variation margin settled-to-market (Level 2).

Forward Contracts

The fair values of forward contracts on to-be-announced securities are determined using quoted prices in active markets or benchmarked thereto (Level 1).

Interest Rate Lock Commitments

The fair values of IRLCs are determined using the projected sale price of individual loans based on changes in market interest rates, projected pull-through rates (the probability that an IRLC will ultimately result in an originated loan), the reduction in the value of the applicant’s option due to the passage of time, and the remaining origination costs to be incurred based on management’s estimate of market costs (Level 3).

The following tables present the fair value measurements of assets and liabilities recognized in the accompanying condensed consolidated balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2023 and December 31, 2022.


			September 30, 2023 Fair Value Measurements Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Government-sponsored agencies	$	97,178	$	—	$	97,178	$	—
Municipal securities	62,772		—		62,772		—
Agency mortgage-backed securities - residential	193,096		—		193,096		—
Agency mortgage-backed securities - commercial	36,163		—		36,163		—
Private label mortgage-backed securities - residential	18,576		—		18,576		—
Asset-backed securities	6,703		—		6,703		—
Corporate securities	36,339		—		36,339		—

Total available-for-sale securities	$	450,827	$	—	$	450,827	$	—

Servicing asset	9,579		—		—		9,579

Interest rate swap agreements	8,934		—		8,934		—
Interest rate swap agreements - assets (back-to-back)	81		—		81		—
Interest rate swap agreements - liabilities (back-to-back)	81		—		81		—


			December 31, 2022 Fair Value Measurements Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Government-sponsored agencies	$	33,809	$	—	$	33,809	$	—
Municipal securities	67,276		—		67,276		—
Agency mortgage-backed securities - residential	215,092		—		215,092		—
Agency mortgage-backed securities - commercial	15,840		—		15,840		—
Private label mortgage-backed securities - residential	10,455		—		10,455		—
Asset-backed securities	4,960		—		4,960		—
Corporate securities	42,952		—		42,952		—

Total available-for-sale securities	$	390,384	$	—	$	390,384	$	—
Loans held-for-sale (mandatory pricing agreements)	9,110		—		9,110		—
Servicing asset	6,255		—		—		6,255

Interest rate swap agreements	8,645		—		8,645		—
Forward contracts	97		97		—		—
IRLCs	133		—		—		133

The following tables reconcile the beginning and ending balances of recurring fair value measurements recognized in the accompanying condensed consolidated balance sheets using significant unobservable (Level 3) inputs for the three and nine months ended September 30, 2023 and 2022.


	Three Months Ended
(in thousands)	Servicing Asset		Interest Rate Lock Commitments
Balance, July 1, 2023	$	8,251	$	—
Total realized gains
Additions:
Originated and purchased servicing	1,585		—
Subtractions:
Paydowns	(408)		—
Change in fair value	151		—

Balance, September 30, 2023	$	9,579	$	—

Balance as of July 1, 2022	$	5,345	$	462
Total realized gains
Additions:
Originated and purchased servicing	783		—
Subtractions:
Paydowns	(279)		—
Change in fair value	(54)		(850)
Balance, September 30, 2022	$	5,795	$	(388)


	Nine Months Ended
(in thousands)	Servicing Asset		Interest Rate Lock Commitments
Balance, January 1, 2023	$	6,255	$	133
Total realized gains
Additions:
Originated and purchased servicing	3,994		—
Subtractions:
Paydowns	(1,275)		—
Change in fair value	605		(133)

Balance, September 30, 2023	$	9,579	$	—

Balance as of January 1, 2022	$	4,702	$	718
Total realized gains
Additions:
Originated and purchased servicing	2,193		—
Subtractions:
Paydowns	(888)		—
Change in fair value	(212)		(1,106)
Balance, September 30, 2022	$	5,795	$	(388)

The following describes the valuation methodologies and inputs used for assets measured at fair value on a nonrecurring basis, as well as the general classification of such assets pursuant to the valuation hierarchy.

Collateral Dependent Loans

Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment. The amount of impairment may be determined based on the fair value of the underlying collateral, less costs to sell, the estimated present value of future cash flows or the loan’s observable market price.

If the impaired loan is identified as collateral dependent, the fair value of the underlying collateral, less costs to sell, is used to measure impairment. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. If the impaired loan is not collateral dependent, the Company utilizes a discounted cash flow analysis to measure impairment.

Impaired loans with a specific valuation allowance based on the value of the underlying collateral or a discounted cash flow analysis are classified as Level 3 assets.

The following table presents the fair value measurements of assets and liabilities recognized in the accompanying condensed consolidated balance sheets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurement falls at September 30, 2023 and December 31, 2022.


			September 30, 2023
(in thousands)			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Collateral dependent loans	$	1,144	$	—	$	—	$	1,144


			December 31, 2022
(in thousands)			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	1,164	$	—	$	—	$	1,164

Significant Unobservable (Level 3) Inputs

The following tables present quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements.

(dollars in thousands)

Fair Value at
September 30, 2023

Valuation
Technique

Significant Unobservable
Inputs

Range

Weighted-Average Range

Collateral dependent loans

1,144

Fair value of collateral

Discount for type of property and current market conditions

0%- 30%

22%

Servicing asset

9,579

Discounted cash flow

Prepayment speeds

Discount rate

0% - 25%

15%

11.3%

15%


(dollars in thousands)	Fair Value at December 31, 2022		Valuation Technique	Significant Unobservable Inputs	Range	Weighted-Average Range
Impaired loans	$	1,164	Fair value of collateral	Discount for type of property and current market conditions	0% - 25%	20%

IRLCs	133		Discounted cash flow	Loan closing rates	31% - 100%	89%
Servicing asset	6,255		Discounted cash flow	Prepayment speeds Discount rate	0% - 25% 14%	14.6% 14%

The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying condensed consolidated balance sheets at amounts other than fair value.

Cash and Cash Equivalents

For these instruments, the carrying amount is a reasonable estimate of fair value.

Securities Held-to-Maturity

Level 2 securities include agency mortgage-backed securities - residential, municipal securities and corporate securities. Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities.

Loans Held-for-Sale (best efforts pricing agreements)

The fair value of these loans approximates carrying value.

Loans

The fair value of loans is estimated on an exit price basis incorporating discounts for credit, liquidity and marketability factors.

Accrued Interest Receivable

The fair value of these financial instruments approximates carrying value.

Federal Home Loan Bank of Indianapolis Stock

The fair value of this financial instrument approximates carrying value.

Deposits

The fair value of noninterest-bearing and interest-bearing demand deposits, savings and money market accounts approximates carrying value. The fair value of fixed maturity certificates of deposit and brokered deposits are estimated using rates currently offered for deposits of similar remaining maturities.

Advances from Federal Home Loan Bank

The fair value of fixed rate advances is estimated using rates currently available for advances with similar remaining maturities. The carrying value of variable rate advances approximates fair value.

Subordinated Debt

The fair value of the Company’s publicly traded subordinated debt is obtained from quoted market prices. The fair value of the Company’s remaining subordinated debt is estimated using discounted cash flow analysis, based on current borrowing rates for similar types of debt instruments.

Accrued Interest Payable

The fair value of these financial instruments approximates carrying value.

Commitments

The fair value of commitments to extend credit are based on fees currently charged to enter into similar agreements with similar maturities and interest rates. The Company determined that the fair value of commitments was zero based on the contractual value of outstanding commitments at each of September 30, 2023 and December 31, 2022.

The following tables present the carrying value and estimated fair value of all financial assets and liabilities that are not measured at fair value on a recurring basis at September 30, 2023 and December 31, 2022.


	September 30, 2023 Fair Value Measurements Using
(in thousands)	Carrying Amount		Fair Value		Quoted Prices In Active Market for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash and cash equivalents	$	521,205	$	521,205	$	521,205	$	—	$	—

Securities held-to-maturity, net	231,928		201,650		—		201,650		—
Loans held-for-sale (best efforts pricing agreements)	31,669		31,669		—		31,669		—
Net loans	3,698,616		3,480,892		—		—		3,480,892
Accrued interest receivable	23,761		23,761		23,761		—		—
Federal Home Loan Bank of Indianapolis stock	28,350		28,350		—		28,350		—
Deposits	4,083,545		4,070,758		1,746,502		—		2,324,256
Advances from Federal Home Loan Bank	614,933		595,177		—		595,177		—
Subordinated debt	104,761		101,920		31,820		70,100		—
Accrued interest payable	2,968		2,968		2,968		—		—


	December 31, 2022 Fair Value Measurements Using
(in thousands)	Carrying Amount		Fair Value		Quoted Prices In Active Market for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash and cash equivalents	$	256,552	$	256,552	$	256,552	$	—	$	—

Securities held-to-maturity	189,168		168,483		—		168,483		—
Loans held-for-sale (best efforts pricing agreements)	12,401		12,401		—		12,401		—
Net loans	3,467,664		3,225,845		—		—		3,225,845
Accrued interest receivable	21,069		21,069		21,069		—		—
Federal Home Loan Bank of Indianapolis stock	28,350		28,350		—		28,350		—
Deposits	3,441,245		3,415,390		1,974,344		—		1,441,046
Advances from Federal Home Loan Bank	614,928		596,455		—		596,455		—
Subordinated debt	104,532		102,669		32,560		70,109		—
Accrued interest payable	2,913		2,913		2,913		—		—

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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